Wednesday, August 17, 2011
So the SNB didn't hit the button on a floor for EURCHF in the end, though the fact that it is still "out there" in policy circles probably means that the disorderly one-way appreciation of the Franc that had been seen in recent weeks. The battle appears to have been won this time, but it will take a while to see whether the war has been won. TMM suppose that the Cantons are still reluctant to increase their investments in SNB LLC given it is on course to produce two down years in a row.
But the money market measures announced and enacted have been exceptionally aggressive, taking on a new level of intervention in the FX Forward market and driving 3m implied rates as low as -1.5% (see chart below). Now, this obviously is intended to provide something of a barrier to speculative longs in the Franc, but as many have noted, much of the move has been due to capital flight from the Euro periphery and Switzerland's running of something like a 15% Current Account surplus which had previously been intermediated and recycled by UBS et al...
...who have been shrinking their balance sheets since 2007:
However, in forcing the cross-currency basis so negative, the SNB are either unintentionally (or for the tin foil beanie brigade, *intentionally*) providing a mechanism to force the Fed's balance sheet to involuntarily expand... QE3 by stealth?!
TMM are, of course, talking about the impact that highly negative rates in the FX Forward market have upon the Fed/SNB FX Swap lines. It seems that Swiss banks can borrow USDs from the SNB/Fed FX Swap facility at around 1.1%, which means that as implied CHF rates fall below around -1.1% there is an arbitrage which when accessed will result in an increased supply of USD and expansion of the Fed's balance sheet. Given just how aggressive the SNB have been on their intervention, they are providing a significant incentive to Swiss banks to engage in such a strategy. TMM wonder how happy the Fed will be with such an expansion, though they would note that it requires no additional policy actions on their part. Something, perhaps, Ben will be pleased with given the recent vitriol spouting from some of the Republican contenders.
On a related note, TMM have noted a lot of commentary on EuroSwiss 3m Libor futures trading above 100 (See chart below). This is something that perplexes them somewhat, because back when they learned about the Eurodollar market and its origins, they remember being told that such deposits were "offshore" and therefore not subject to domestic regulations (with respect to USD deposits in the early-1980s , these were interest rate caps etc). The result was a significant difference between domestic rates and offshore rates - something that EM traders will instantly recognise.
This was one of the original drivers behind the introduction of the basis swap market and, indeed, the USDCHF 1yr basis (see chart below) has begun to move negative in earnest and following on from the recent money market actions. But markets have never really approached a point where rates have been so close to zero that onshore/offshore effects are so dramatic. Japan never saw 3m Libor go negative (offshore) nor 3m Tibor, though the FX Forward market again saw negative rates (again, a cross-currency basis effect). And TMM find it hard to imagine an offshore deposit transacting at all at a negative rate given there isn't really a mechanism for it to do so - though they do accept that it is plausible that money centre banks might impose depository charges independently, this seems particularly unlikely given that reserves at overseas subsidiaries of bank holding companies do not (as far as TMM are aware, count towards regulatory limits domestically - please let us know in the comments if we are wrong on this one!). Finally, TMM also are sympathetic to the idea that given the banks on the Libor panel for CHF, that they might collude in some manner to produce negative Libor, even if they were not actually transacting deposits at such a level. However, TMM reckon that given the uproar last time there were questions regarding the accuracy of the Libor fixes, that these banks might not want to open themselves up to further political and regulatory pressure.
That said, TMM are sure plenty of swaption desks are short 0% strikes and prices may merely move higher on their "hedging" activities, and thus it is hard to stand in the way of the train, even if they are relatively (though not completely) sure that 3m CHF Libor won't go negative and at expiry the trade would most likely pay off.
Other than that, TMM don't really have much of an opinion on markets at these levels, as we seem to be hovering around pivot points in Spooz, the Euro and pretty much everything else. The hard data (notably IP yesterday) seem to have generally been OK-to-good, but the soft data (Empire etc) have taken a further turn down, so it is hard to see the wood for the trees. But TMM do hold the view that as volatility decreases, it will not be long before the carry monkeys start to pick up some bargains.